Now that you know when to use an RRSP and that we've determined that it's the right vehicle for your investments, let's figure out how much you're allowed to contribute to it.
Your RRSP contribution for any given year is the lower of:
- 18% of your earned income from the previous year
- The maximum annual contribution limit for the taxation year (posted by the CRA online)
- The remaining limit after any company-sponsored pension plan contribution or group RRSP contribution
Additionally, any unused contribution room from the years 1991-2014 can be carried forward to the current year. This means that if you worked in the past and didn't use your contribution room, you can still use it today! Also, every Canadian is allowed to over-contribute $2,000 once in their lifetime but if you over-contribute beyond this amount, you'll be charged a penalty tax of 1% of the over-contribution amount per month.
Great, so now that you know the rules around the contributions, it's time to determine how much you should be putting aside. Although it's not always easy, we recommend saving about 20% of your income for future you. The more you save, the better off you will be in the future. Here is a good practice for saving:
- Make a budget and determine your monthly expenses. Be realistic. From your income, make sure you keep enough to cover those expenses.
- The income above your monthly expenses can go towards your savings.
- Before contributing to your RRSP, make sure to keep 3-6 months of living expenses in an emergency fund - This is money that can be used in case of an unexpected expense. These funds should be in a chequing or savings account to make sure they're liquid and accessible.
- Once you have a well-cushioned emergency fund, any additional income above your monthly expenses can be contributed to your RRSP.
Eventually, you will have maxed out your RRSP contribution room. If you have additional funds you'd like to invest, you should consider using a TFSA. If you're not eligible for a TFSA or it's already maxed out, then you'll have to use a personal account.